Demand and capital "plentiful", but lower profit margins and limited assets testing lenders, report says
Rising interest rates and increasing construction costs are the biggest threats to the commercial real estate sector, according to a new report by industry data provider, LightBox.
The 18-page ‘Investor Sentiment Report’, covering data during the first quarter this year, said record high inflation and the prospect of higher interest rates were “tangible threats” that were causing investors to revise profit expectations.
Interest rates for a 30-year fixed mortgage rose from around 3.40% at the beginning of the year to 4.73% at the end of March, while jumbo loans saw rates jump from 3.35% to 4.45% during the same period.
Meanwhile, inflation rose from 7% in January to 8.5% in March, the highest level in 40 years.
LightBox noted that the US commercial property market ended 2021 with record activity, including more than $300 billion in sales across all property types during the fourth quarter alone.
The report added that CRE investors were “navigating a complex landscape” where demand and capital were plentiful, thanks to strong GDP growth and unemployment moving back to pre-pandemic levels.
This would explain why 72% of respondents said they expected commercial property investment sales volume to exceed 2021 levels.
However, threats to the short-term outlook from inflation, construction costs and rising interest rates were now causing investors to revise their profit expectations, just as the market was witnessing robust growth in multifamily and industrial and reporting a continued recovery in office, retail, and hospitality.
Tina Lichens (pictured), chief operating officer at LightBox who conducted and compiled the report, said her biggest surprise compiling the study was the “frenzy of activity” in the market, even when compared to 2019, which she described as a benchmark year.
“We’ve never seen this kind of activity in terms of properties coming on to the market. It’s insane. And it’s all asset classes all across the US,” she said.
Asked why the sector was so buoyant, she said: “There are always going to be opportunities. Our debt professionals and mortgage broker clients are telling us that because there’s so much liquidity in the market, there are many more debt funds out there and more financing options than ever before.”
Despite the evident growth, doubts were now emerging inside the CRE space in response to inflationary pressures, with experts foreseeing lower profit margins compared to last year. The report also noted that despite the fact there was significant capital allocated to the CRE sector, there was limited availability of assets in certain sub sectors, such as industrial.
Speaking to Mortgage Professional America (MPA), she said that while investors were decidedly optimistic about the future of the market, lenders were more downbeat. “When you’re talking to lenders, you’re generally seeing less optimism. They are starting to become bearish, and that wasn’t the case three months ago,” she said.
Multifamily and industrial assets were ranked as the top choices, with retail as the least favored and the office sector continuing to struggle with vacancies.
Regarding the latter, Lichens said that although there was evidence people were returning to the office in large numbers, particularly in cities such as Austin, there was still a lot of uncertainty about the future of the workplace.
“There’s a record number of office leasing expiring this year. So maybe there’ll be a small uptick in office properties coming on the market, as savvy investors will be looking at leases coming up for renewal,” she suggested.
Inflation was, however, the recurring theme, also among homebuilders. “I think that what’s actually playing out is going to be much more dramatic than what people have predicted,” she said.
“It’s scary because you’re paying so much more for your employees, for materials and for everything. You’re in a shrinking margin type of environment, and you’ve got to factor that into everything that you’re doing.”
The impact on lenders was such that many were attempting to reduce the risk by partnering with other firms. However, this also meant that they were focusing on far larger loan amounts, to the detriment of the middle market, she concluded.